Congrats on the exciting transition! I’m sure you’ve read baby books or listened to podcasts about becoming a parent. You may be appreciating your final full-night sleeps before the baby comes, or you may be smack in the middle of raising a newborn.
There are many exciting transitions during this stage of life – but what about your finances?
Having your first child triggers many important decisions in your financial life. Your somewhat simple financial life suddenly becomes more complex. You now have a child who is completely financially dependent on you.
You may feel overwhelmed and after a few failed google searches of “what to do financially when you’re a new parent”, you’ve given up. But don’t worry…
The purpose of this blog is to break down 5 different ways your financial life is impacted when having your first child and the key conversations/decisions to make for each.
1) Discuss the impact on your careers
The most consistent value that I have heard from parents is to be present and involved in their children’s life. When you really cut to the core of what is most important, you find it is quality time with the people you love most.
With this exciting life change, it’s so important for you and your partner to reevaluate your careers. Are you working 60 hours a week? Do you feel like a slave to your job? Does your job provide lifestyle flexibility?
The first few years of a child’s life are some of the most formative. In fact, it is estimated that 90% of the brain’s capacity has already developed by the age of five. Often times, we can fall into the trap of missing out on these years by working too much given the pressure to financially support the family.
Yes, it’s important not to spend more than you make, but here’s a bit of advice parents need to hear. It is okay to hit pause on your financial savings during the first few years as a new parent.
It’s not the end of the world if you aren’t maxing out your 401(k). You don’t need to start saving for college day one. Rapidly paying down student loans can wait. Your life should always drive your financial decisions. Your financial decisions shouldn’t drive your life.
Reevaluate your careers through this lens and explore different types of investments that you can make to free up your time to spend with your children. Something as small as hiring someone to clean your house can go a long way.
2) Adjust your cash flow
Your cash flow will certainly change. Your monthly spending will go up and your income may change depending on what you decide with your careers. You should be prepared for this transition so you avoid going into debt.
In order for you to make solid, data-driven financial decisions, I strongly recommend tracking your spending so you know how much it costs to live your lifestyle.
There is a massive difference between saying “Our spending will go up” vs. “Our current monthly spending is $8,000/month and we anticipate this increasing to $10,000/month after having a child”.
The latter allows you to make smarter, data-driven decisions so you can better understand how much income you need to earn and how to prioritize your savings. This is why I reframe “budgeting” as “awareness” – awareness to how much it costs to live your lifestyle and how your spending is aligned with your values. Tracking your spending could give you the confidence that you would be financially okay if you do decrease your income so you can spend more time with your child in some of the most precious years of their life.
Knowing your average monthly spending is a great starting point, but it’s impossible to accurately predict how much it will increase once you have kids. This is why boosting your emergency fund makes a lot of sense when you have a new child. Rather than having the typical 3 months of living expenses saved up in a bank account, I recommend having at least 6 months of living expenses saved up so you don’t feel stressed when those diapers and medical bills come in higher than expected.
3) Reevaluate your health insurance coverage
Whether you are covered by an employer plan or by a state plan, it’s important for you to reevaluate your health insurance coverage.
In particular, there are two key features to look at – your annual deductible and your out of pocket maximum. A deductible is the amount that you pay out of pocket before your health insurance kicks in. The out of pocket maximum is the most that you can pay for medical costs in a calendar year for covered benefits. After you hit the out of pocket maximum, your insurance covers 100% of the cost.
Without kids (assuming you are healthy), you can usually fly by with a pretty low-cost health insurance plan. You can have a higher deductible and out of pocket maximum (which lowers your monthly premium) since your medical expenses are estimated to be pretty low.
Upon having kids, you may want to explore health insurance plans that have a lower deductible and a lower out of pocket maximum, so you aren’t caught by surprise when medical expenses are higher.
That being said, you may want to still choose a “high deductible” health plan (defined as a deductible of $1,400 for individual or $2,800 for family) so you can contribute to a Health Savings Account. This is an extremely powerful long-term savings account, but you can only contribute to it if you are covered by a high deductible health plan.
On a somewhat related note, if you are not self-employed, then your employer may also offer a Dependent Care Flexible Spending Account. This would allow you to contribute up to $2,500 (if married filing separately) or $5,000 (if single or married filing jointly) pre-tax to cover qualified dependent care expenses for when your child is under the age of 13. This means if you have a nanny or use day care, you can pay for the cost using up to $5,000 of pre-tax dollars which could save you a few thousand in taxes.
4) Purchase more life insurance
*I do not sell life insurance. I am completely independent and write this purely from an objective standpoint 😊.
Before having kids, your life insurance needs are probably relatively low. You may have some coverage to pay off the mortgage or support your spouse if something were to happen to you. However, once you have kids, your life insurance needs significantly increase. You now have someone whose entire life (plus cost of college!) is financially dependent on you.
There are two parts in determining the right life insurance plan – the amount of life insurance you need and the type of life insurance you need.
How much life insurance is enough?
There are two main factors to answer this – 1) what level of monthly expenses do you need to maintain so your standard of living doesn’t dramatically change and 2) would the surviving partner generate income?
Ideally, you would want your family to maintain a similar lifestyle if something were to happen to you. If you are spending $15k/month right now, you probably want to plan for continuing to spend that same amount moving forward.
A good starting point is to take the amount you spend on an annual basis and multiply it by 25. This stems from the idea that a 4% spending rate from your investment portfolio has historically been a sustainable withdrawal rate. This means if you spend $15k/month (or $180,000/year), you would need to have $4.5 million of life insurance to safely spend $15k/month.
What if you already have money saved up? Then subtract that from the $4.5 million. So, if you have $500,000 saved up now, you would need $4 million of life insurance coverage.
However, this calculation assumes that the surviving partner would not work. Using the same $15k/month expense amount, let’s assume that the surviving partner would in fact go back to work and earn $8k/month after-tax. This means your monthly shortfall is now $15k – $8k = $7k, which means your annual portfolio withdrawals are $7k * 12 = $84,000. In turn, this implies that you would need $2.1 million ($84,000 * 25) of life insurance, as opposed to $4 million.
You can see how this isn’t black and white. There are many variables to consider when figuring out how much life insurance is right for you. Bottom line – get more life insurance coverage.
What type of life insurance should you buy?
I consider life insurance to be a necessary expense to protect against a very unfortunate event. I do not believe life insurance is an “investment”. Often times, people try to sell life insurance to you as an “investment vehicle” by having you buy some type of whole life or universal life insurance policy. These types of policies are permanent insurance and often carry extremely high costs.
In my opinion, there are very few instances where permanent insurance is needed. The overwhelming majority of young families simply need life insurance to protect against the loss of their income. This is why I strongly recommend buying term life insurance.
This type of insurance works exactly like it sounds. You buy low cost insurance to cover you for a certain amount of time. You likely don’t need insurance when the kids are out of college, so why pay for it?
Term insurance gives you the ability to buy the exact amount of coverage that you need at a certain time. Don’t make it more complicated than that.
If you are employed, you likely have some type of group life insurance paid by your employer. It is typically equal to your annual salary and some employers offer the option to purchase supplemental life insurance at pretty low rates. However, your employer-sponsored life insurance may not be enough for you and it could leave you uninsured if you happened to lose your job. This is why it’s important to also considering private term life insurance.
5) Create an estate plan
*I am not an estate attorney and recommend you speak with one to confirm your unique needs.
The overwhelming majority of young families don’t have an estate plan. Similar to financial planning, I think there is the perception that you don’t need an estate plan until you’ve accumulated a large amount of assets. This is not true!
Yes, there are some estate planning documents that are only applicable to those with a very high net worth, but there are basic estate planning documents that I believe everyone (especially young families) should have in place.
A Will serves many purposes – naming an executor, outlining disposition of assets owned in your own name, etc.
One of the most important parts (and likely most relevant for you) of creating a will is to name guardians for your children. You don’t want to leave the decision of guardianship up to a court – it’s a critical decision that you want to control. I recommend having conversations with the people named as guardians ahead of time, so you feel comfortable with the decision and they aren’t taken by surprise.
Health Care Proxy
A Health Care Proxy is a document that appoints people (often your partner) to make medical decisions on your behalf if you are incapable of making healthcare decisions on your own. The rules vary by state, but if you don’t have a specific health care agent named, your spouse may not be the only one who has say over medical decisions.
By naming a health care agent, you take the “guessing” piece out of the equation during a time of extremely heightened emotions. Ideally, you have discussed your wishes with the health care agent ahead of time, so they aren’t doubting their decisions.
A HIPAA Release allows medical professionals to disclose information about your health history to the named people in the document. The people named in this document usually match that of the Health Care Proxy.
Financial Durable Power of Attorney
A Financial Durable Power of Attorney allows someone to make financial decisions on your behalf. The specific provisions are important – it can either be effective immediately or upon incapacity.
So how do you complete these documents?
The best way to complete these documents is to work with an estate attorney that is licensed in your state. They know the ins and outs of state laws and are able to customize recommendations based upon your specific needs. A basic estate plan usually costs a few thousand dollars or so. If you are working with a financial planner, you can lean on them to make introductions and facilitate the process.
Yes, there are cheaper online solutions like Trust and Will, but be careful – you get what you pay for. If you are unable to afford an estate attorney, then an online platform is likely better than doing nothing. However, I strongly believe you are better off hiring an estate planning attorney if you have the financial means to do so.
- Having your first child is a very exciting, yet transitional event. Your life isn’t as simple as it used to be. This is why working with a fee-only financial planner is so important. Do you have the time, energy and ability to successfully navigate all of the actions outlined here? Probably not 🙃.
- Don’t lose perspective of what is most important to you. We can get caught up in the day to day activities and stress of money. 10 years from now, you will look back and remember the meaningful experiences with your kids, not the fact that you paid off student loans 2 years faster.
- That being said, be smart about this financial transition. There is a big difference between reducing your saving vs. going into debt. You don’t want your near-term financial decisions to push you backwards, but it’s okay not to move forward immediately during this transition. Strive to keep your long-term investments intact and become a steward of your cash flow.
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